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Price Discovery in the U.S. Treasury Market, The Impact of Orderflow and Liquidity on the Yield Curve
 Journal of Finance
, 2004
"... Financial Research at the Wharton School of the University of Pennsylvania is gratefully acknowledged. All We examine the role of price discovery in the U.S. Treasury market through the empirical relationship between orderflow, liquidity, and the yield curve. We find that orderflow imbalances (exces ..."
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Cited by 83 (5 self)
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Financial Research at the Wharton School of the University of Pennsylvania is gratefully acknowledged. All We examine the role of price discovery in the U.S. Treasury market through the empirical relationship between orderflow, liquidity, and the yield curve. We find that orderflow imbalances (excess buying or selling pressure) account for up to 26 % o f t h e d a ytoday variation in yields on days without major macroeconomic announcemen ts. The effect of orderflow on yields is permanent and strongest when liquidity is low. All of the evidence points toward an important role of price discovery in understanding the behavior of the yield curve. The use of riskless interest rates permeates virtually every facet of economics and finance. It is therefore critical to understand the behavior of the term structure of riskless interest rates, or the yield curve, which gives the mapping between the maturity of a riskless loan and its rate. Much of the term structure literature focuses on factor models in which, at each date, the yields on all bonds with different maturities are determined by the realizations of a few common factors (e.g., Vasicek (1977); Cox, Ingersoll and Ross (1985)). The consensus is that more than one, but not
Jumps in financial markets: A new nonparametric test and jump clustering
, 2007
"... This article introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intraday level. We demonstrate that the likelihood of misclassification of jumps becomes negligible when we use highfrequency returns. Using our test, we examine jump dyn ..."
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Cited by 71 (4 self)
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This article introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intraday level. We demonstrate that the likelihood of misclassification of jumps becomes negligible when we use highfrequency returns. Using our test, we examine jump dynamics and their distributions in the U.S. equity markets. The results show that individual stock jumps are associated with prescheduled earnings announcements and other companyspecific news events. Additionally, S&P 500 Index jumps are associated with general market news announcements. This suggests different pricing models for individual equity options versus index options. (JEL G12, G22, G14) Financial markets sometimes generate significant discontinuities, socalled jumps, in financial variables. A number of recent empirical and theoretical studies proved the existence of jumps and their substantial impact on financial management, from portfolio and risk management to option and bond pricing
Regime shifts in a dynamic term structure model of U.S. Treasury bond yields, Working paper, Stern School of Business
, 2003
"... This paper develops and empirically implements an arbitragefree, dynamic term structure model with “priced ” factor and regimeshift risks. The risk factors are assumed to follow a discretetime Gaussian process, and regime shifts are governed by a discretetime Markov process with statedependent ..."
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Cited by 67 (5 self)
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This paper develops and empirically implements an arbitragefree, dynamic term structure model with “priced ” factor and regimeshift risks. The risk factors are assumed to follow a discretetime Gaussian process, and regime shifts are governed by a discretetime Markov process with statedependent transition probabilities. This model gives closedform solutions for zerocoupon bond prices and an analytic representation of the likelihood function for bond yields. Using monthly data on U.S. Treasury zerocoupon bond yields, we document notable differences in the behaviors of the market prices of factor risk across high and low volatility regimes. Additionally, the statedependence of the regimeswitching probabilities is shown to capture an interesting asymmetry in the cyclical behavior of interest rates. The shapes of the term structures of bond yield volatilities are also very different across regimes, This paper develops and empirically implements an arbitragefree, dynamic term structure model (DTSM) with “priced ” factor and regimeshift risks. The risk factors are assumed to follow a discretetime Gaussian process, and regime shifts are governed by a discretetime Markov process with statedependent transition probabilities. Agents are assumed to know
Risk Premiums in Dynamic Term Structure Models with . . .
, 2010
"... This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and ..."
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Cited by 66 (10 self)
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This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and inflation risks – impact bond investment decisions separately from information about the shape of the yield curve. Estimates of our preferred macroDT SM over the twentythree year period from 1985 through 2007 reveal that unspanned macro risks explained a substantial proportion of the variation in forward terms premiums. Unspanned macro risks accounted for nearly 90 % of the conditional variation in shortdated forward term premiums, with unspanned real economic growth being the key driving factor. Over horizons beyond three years, these effects were entirely attributable to unspanned inflation. Using our model, we also reassess some of Chairman Bernanke’s remarks on the interplay between term premiums, the shape of the yield curve, and macroeconomic activity.
A New Perspective on Gaussian Dynamic Term Structure Models,"
 Review of Financial Studies,
, 2010
"... Abstract In any canonical Gaussian dynamic term structure model (GDTSM), the conditional forecasts of the pricing factors are invariant to the imposition of noarbitrage restrictions. This invariance is maintained even in the presence of a variety of restrictions on the factor structure of bond yie ..."
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Cited by 47 (8 self)
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Abstract In any canonical Gaussian dynamic term structure model (GDTSM), the conditional forecasts of the pricing factors are invariant to the imposition of noarbitrage restrictions. This invariance is maintained even in the presence of a variety of restrictions on the factor structure of bond yields. To establish these results, we develop a novel canonical GDTSM in which the pricing factors are observable portfolios of yields. For our normalization, standard maximum likelihood algorithms converge to the global optimum almost instantaneously. We present empirical estimates and outofsample forecasts for several GDTSMs using data on U.S. Treasury bond yields.
Accounting for a Shift in Term Structure Behavior with NoArbitrage and MacroFinance Models
, 2005
"... This paper examines a shift in the dynamics of the term structure of interest rates in the U.S. during the mid1980s. We document this shift using standard interest rate regressions and using dynamic, affine, noarbitrage models estimated for the pre and postshift subsamples. The term structure sh ..."
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Cited by 45 (8 self)
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This paper examines a shift in the dynamics of the term structure of interest rates in the U.S. during the mid1980s. We document this shift using standard interest rate regressions and using dynamic, affine, noarbitrage models estimated for the pre and postshift subsamples. The term structure shift largely appears to be the result of changes in the pricing of risk associated with a “level factor. Using a macrofinance model, we suggest a link between this shift in term structure behavior and changes in the dynamics and risk pricing of the Federal Reserve’s inflation target as perceived by investors.
Optimal filtering of jump diffusions: extracting latent states from asset prices
, 2007
"... This paper provides a methodology for computing optimal filtering distributions in discretely observed continuoustime jumpdiffusion models. Although it has received little attention, the filtering distribution is useful for estimating latent states, forecasting volatility and returns, computing mo ..."
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Cited by 44 (8 self)
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This paper provides a methodology for computing optimal filtering distributions in discretely observed continuoustime jumpdiffusion models. Although it has received little attention, the filtering distribution is useful for estimating latent states, forecasting volatility and returns, computing model diagnostics such as likelihood ratios, and parameter estimation. Our approach combines timediscretization schemes with Monte Carlo methods to compute the optimal filtering distribution. Our approach is very general, applying in multivariate jumpdiffusion models with nonlinear characteristics and even nonanalytic observation equations, such as those that arise when option prices are available. We provide a detailed analysis of the performance of the filter, and analyze four applications: disentangling jumps from stochastic volatility, forecasting realized volatility, likelihood based model comparison, and filtering using both option prices and underlying returns.
Financial Markets and the Real Economy
, 2006
"... I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” ..."
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Cited by 44 (4 self)
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I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” I survey the literature, covering the timeseries and crosssectional facts, the equity premium, consumptionbased models, general equilibrium models, and labor income/idiosyncratic risk approaches.
AritrageFree Bond Pricing with Dynamic Macroeconomic Models. Federal Reserve Bank of St. Louis Review
, 2007
"... We examine the relationship between monetarypolicyinduced changes in short interest rates and yields on longmaturity defaultfree bonds. The volatility of the long end of the term structure and its relationship with monetary policy are puzzling from the perspective of simple structural macroecono ..."
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Cited by 40 (14 self)
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We examine the relationship between monetarypolicyinduced changes in short interest rates and yields on longmaturity defaultfree bonds. The volatility of the long end of the term structure and its relationship with monetary policy are puzzling from the perspective of simple structural macroeconomic models. We explore whether richer models of risk premiums, speci cally stochastic volatility models combined with EpsteinZin recursive utility, can account for these patterns. We study the properties of the yield curve when in ation is an exogenous process and compare this to the yield curve when in ation is endogenous and determined through an interestrate/Taylor rule. We nd that the EpsteinZin model with moderate risk aversion, persistent volatility of real endowment growth, and exogenous in ation, does a good job of matching the shape of the historical average yield curve. However, it exhibits less volatility in long rates than found in the data. We add to this environment a Taylor rule that raises the short interest rate aggressively in response to current in ation, and resolve for yields using the endogenous equilibrium process for in ation. We nd that risk premiums increase